MiFID II requirements do not align with US practices governing the exchange of commissions for execution and research. But a token-based research platform enables a solution that simultaneously complies with regulatory regimes on both sides of the Atlantic, enhances the user experience and generates a network effect that increases the size of the research market in the US.
In Parts 1 and 2, we proposed a token, smart contract and blockchain-based research platform whereby non-currency tokens enable an alternative research payment option to the RPA and P&L options. Satisfying one set of regulations or the other is less than optimal as a long-term solution when both systems clearly offer desirable benefits. As such, the token-based research method enables a solution that simultaneously addresses MiFID II and Section 28(e) dissonance, complying with regulatory regimes on both sides of the Atlantic, enabling the best features from each regulatory environment, and creating a path to sustainable profitability and continued innovation for asset manager and brokerage firms in the U.S.
In Part 3, we examine the operations and benefits from a research platform that, in turn, satisfies all regulatory requirements while reducing friction, enhancing user experience and generating a “two-sided network effect” that increases both quantity and quality of research. These benefits include:
- Research Acquisition Utilizes Tokens: The acquisition and distribution of research in the US operates as a non-currency token-based rewards system rather than through the direct purchase of research funded by soft dollar expenditures.
- The Use of Section 28(e) Safe Harbor is Maintained: The US 28(e) legislative framework remains fully in force in American trading, commission management and research acquisition practices, while the MiFID II requirements are satisfied, as the value of research acquired by asset managers is determined by the number of non-currency research tokens for the specific piece of research.
- Enables Compliance with MiFID II Requirements on a Global Basis while Permitting Continued Use of the 28(e) Safe Harbor in the US: Europe may elect to realize the cost savings and improved business practices of this blockchain-based distributed ledger to track research payments while the US activity realizes the benefits of a token-based research payment method in addition to the continued use of 28(e).
- **Reduces Expensive CMS System and CMS Groups:**A single, distributed, immutable, private blockchain-based system delivers operational and compliance efficiencies.
- Financial Impact on Industry Participants: Many presume that MiFID II delivers clear advantages to large asset managers and could even be the death knell of small asset managers. The low-cost, token-based payment option will enable both larger and smaller asset managers to continue operating in a manner similar to their current operations as they continue providing valuable services to the financial community.
- Tokens Are Redeemable Across Brokerage Firms: A mechanism enabling token redemption across brokerage firms eliminates an inducement to execute through a brokerage firm based on the quality of their research. As such, tokens issued by one brokerage firm may be redeemed with another research provider in a manner that can eliminate improper inducements while promoting greater use of the platform.
- **Secondary Market for Tokens Likely to Form:**It is possible, even likely, that a secondary market forms for transferring ownership of tokens, whereby research could also be valued based on the market price of these tokens.
- **A Platform-Based Modern Market for Research Emerges:**Platforms are used across many industries to enhance user experience, remove friction and lower costs. Airbnb, Lyft and the Apple App Store are examples of successful platforms. New forms of collaboration and community emerge. New sources and consumers of research may emerge. The size of the market grows. The execution for research system is transformed into a modern market where companies use modern marketing, technology and information delivery techniques to promote their research offerings.
Independent research providers (IRPs) may also participate in this research platform, thereby creating a single industry-wide platform for exchanging execution services and research. Global asset managers will no longer need to trade with obscure offshore brokers just to obtain research. Instead, global asset managers may execute through a US broker and purchase research from a local provider with greater expertise. Thus, US, European and Asian markets can all benefit from this research platform.
With regards to initial implementation, the smart contract and token-based research platform is best initially implemented by a small group of participant brokerage firms and asset managers in a “regulatory sandbox” in close cooperation with the regulators.
A True Network Effect for Research
Further, it is well known that platforms have the power to enhance the user experience and bring new sources of supply into the market. The combination of enhanced user experience and new sources of supply often drive down prices and increase the size of the market. An analysis showed that the superior Uber “experience” tripled the size of the taxi market in San Francisco. Similarly, the proliferation and success of electronic trading platforms such as Instinet and Liquidnet are examples of the power and benefits of the network effect.
Therefore, one anticipated benefit of the token, smart contract and blockchain-based research platform is the creation of the “two-sided network effect” of platforms. This network effect is likely to attract new providers and consumers of research. A more positive user experience and lower costs would replicate the experience of other markets where platform-based distribution of products and services has occurred.
A Vision of the Future
The present state of dissonance between MiFID II and Section 28(e) requirements is replaced by a research platform that optimizes the benefits of both regulatory environments while also reducing friction, enhancing the user experience and generating a network effect that increases the size of the research market in the US. New technologies, including platforms, smart contracts, tokens and blockchain, create a digital convergence to enable innovation that improves the user experience for all participants while providing for sustainable profitability and continued innovation in the US research, execution and asset management markets. In addition, the token, smart contract and blockchain-based platform has the potential to incorporate additional leading digital technologies, including the cloud, artificial intelligence, deep learning, natural language processing, virtual and augmented reality, big data and crytocurrencies.
Taking the Research Token Concept Further
Finally, we believe the token-based research payment method is a necessary, but not sufficient, condition for the optimal configuration of research payments in the US. A critical question remains: How does the U.S. execution and research commission model remain economically viable in a post-MiFID II world? As such, it is worth noting that the blockchain-based research platform and token-based research payment method create the potential for an execution vs. research delineation method we call “28(e) Execution.” In our next article, we begin to develop how 28(e) Execution may enable continued innovation and sustainable profitability by US asset manager and brokerage firms in a post-MiFID II environment.
Disclosure: One author, Allan Chiulli, is an inventor of several U.S. patents for the use of non-currency units of exchange in a networked platform for accruing and distributing of research for trade execution services. These include U.S. Patents 8,078,582; 8,396,786; and 8,635,148. The provisional patent for this family of patents was filed in March 2007 while the formal application was filed in March 2008. In comparison, the Satoshi Nakamoto paper introducing the Bitcoin and Blockchain concepts, “Bitcoin: A Peer-to-Peer Electronic Cash System,” was published in November 2008.
Joel Steinmetz is the CEO of UAT Resources LLC, and a TabbFORUM contributor.